CMA Study Group

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct 
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------

Hello Aaditya,

Hope you are doing great with financial analysis

Kindly note that decision analysis case studies have different ways to ask for calculating the present value for annual net cash flows.
This one has given the annual Operating Income, which should be multiplied by (1 - tax rate) in order to get the annual after-tax net Income.
As we know from the indirect method of Statement of cash Flows, annual depreciation (Non-cash) expense should be added back into net income in order to get the annual net cash flow. (From operating activities)

• Adding back the tax shield to after-tax net profit will keep a portion of depreciation expense included in that profit. (Try to figure it out for one year)
• Tax shield should be added back only to after-tax cash flows calculated by the direct method of SCF.

I recommend that you prepare your own summary notes to illustrate the possible scenarios of how to get the net cash flows according to given info.

With un-even net / discounted cash flows, there is no other way than traditional subtracting calculation.

Hope this was helpful

Kind regards

------------------------------
Samer Ahmad, FMVA, SCA
Kuwait
------------------------------

Original Message:
Sent: 05-27-2020 09:44 AM
From: Aaditya Narayanan Chakravarthy Padmanabhan
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------

Hi all,

However as Mr. Aditya pointe out, the depreciation's tax shield benefit is considered as cashflow and in this scenario, it would have been 32,000 instead of 80,000. 

What do you say?

------------------------------
Muhammed Unain
Director/Manager
------------------------------

Original Message:
Sent: 05-27-2020 06:54 PM
From: Samer Ahmad
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Hello Aaditya,

Hope you are doing great with financial analysis

Kindly note that decision analysis case studies have different ways to ask for calculating the present value for annual net cash flows.
This one has given the annual Operating Income, which should be multiplied by (1 - tax rate) in order to get the annual after-tax net Income.
As we know from the indirect method of Statement of cash Flows, annual depreciation (Non-cash) expense should be added back into net income in order to get the annual net cash flow. (From operating activities)

• Adding back the tax shield to after-tax net profit will keep a portion of depreciation expense included in that profit. (Try to figure it out for one year)
• Tax shield should be added back only to after-tax cash flows calculated by the direct method of SCF.

I recommend that you prepare your own summary notes to illustrate the possible scenarios of how to get the net cash flows according to given info.

With un-even net / discounted cash flows, there is no other way than traditional subtracting calculation.

Hope this was helpful

Kind regards

------------------------------
Samer Ahmad, FMVA, SCA
Kuwait

Original Message:
Sent: 05-27-2020 09:44 AM
From: Aaditya Narayanan Chakravarthy Padmanabhan
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------

------------------------------
APOORV BANSAL
Student
Jaipur
India
------------------------------

Original Message:
Sent: 05-27-2020 09:44 AM
From: Aaditya Narayanan Chakravarthy Padmanabhan
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------

Hi

But both will not give the same result. There will be a difference in the amounts. 

The methods which will give the same result is as follows:

Method 1:

Cash inflow +
Depreciation -
_____________
Net
________
Tax -
________
Add back depreciation 

Method 2:

Cash inflow after tax (x*1-tax%)+
Depreciation tax benefit (x*tax%) -
______

------------------------------
Muhammed Unain
Director/Manager
------------------------------

Original Message:
Sent: 05-28-2020 03:43 AM
From: APOORV BANSAL
Subject: PArt 2 Investment dedcision ( NPV-IRR)

------------------------------
APOORV BANSAL
Student
Jaipur
India

Original Message:
Sent: 05-27-2020 09:44 AM
From: Aaditya Narayanan Chakravarthy Padmanabhan
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------

Bro
Here given Operating Income, not after tax cash flow.
There is difference between after tax cash flow and operating income.

1. After Tax cash flow:
Sales - all cost (except depreciation)
And then add depreciation tax sheild 

2. Operating income: 
PAT : Profit After Tax (sales - all cost including depreciation) 
And then add back depreciation again to reach annual after tax cash flow i.e.

------------------------------
APOORV BANSAL
Student
Jaipur
India
------------------------------

Original Message:
Sent: 05-28-2020 04:04 AM
From: Muhammed Unain
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Hi

But both will not give the same result. There will be a difference in the amounts.

The methods which will give the same result is as follows:

Method 1:

Cash inflow +
Depreciation -
_____________
Net
________
Tax -
________
Add back depreciation

Method 2:

Cash inflow after tax (x*1-tax%)+
Depreciation tax benefit (x*tax%) -
______

------------------------------
Muhammed Unain
Director/Manager

Original Message:
Sent: 05-28-2020 03:43 AM
From: APOORV BANSAL
Subject: PArt 2 Investment dedcision ( NPV-IRR)

------------------------------
APOORV BANSAL
Student
Jaipur
India

Original Message:
Sent: 05-27-2020 09:44 AM
From: Aaditya Narayanan Chakravarthy Padmanabhan
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------

That makes sense ... Thanks for the clarification. 

Questions come twisted and really you have to be careful with the words.

Thanks

------------------------------
Muhammed Unain
Director/Manager
------------------------------

Original Message:
Sent: 05-28-2020 04:28 AM
From: APOORV BANSAL
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Bro
Here given Operating Income, not after tax cash flow.
There is difference between after tax cash flow and operating income.

1. After Tax cash flow:
Sales - all cost (except depreciation)
And then add depreciation tax sheild

2. Operating income:
PAT : Profit After Tax (sales - all cost including depreciation)
And then add back depreciation again to reach annual after tax cash flow i.e.

PAT (Operating Income - Tax)
Add: Depreciation

------------------------------
APOORV BANSAL
Student
Jaipur
India

Original Message:
Sent: 05-28-2020 04:04 AM
From: Muhammed Unain
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Hi

But both will not give the same result. There will be a difference in the amounts.

The methods which will give the same result is as follows:

Method 1:

Cash inflow +
Depreciation -
_____________
Net
________
Tax -
________
Add back depreciation

Method 2:

Cash inflow after tax (x*1-tax%)+
Depreciation tax benefit (x*tax%) -
______

------------------------------
Muhammed Unain
Director/Manager

Original Message:
Sent: 05-28-2020 03:43 AM
From: APOORV BANSAL
Subject: PArt 2 Investment dedcision ( NPV-IRR)

------------------------------
APOORV BANSAL
Student
Jaipur
India

Original Message:
Sent: 05-27-2020 09:44 AM
From: Aaditya Narayanan Chakravarthy Padmanabhan
Subject: PArt 2 Investment dedcision ( NPV-IRR)

Miller Inc. uses straight-line depreciation for both tax and financial reporting purposes. The following data
relate to Machine No. 108, which cost $400,000 and is being written-off over a five-year life.
Year Operating Income
1 $150,000
2 200,000
3 225,000
4 225,000
5 175,000
All of these amounts are on a before-tax basis. Miller is subject to a 40% income tax rate. The company
strives for a 12% rate of return. The traditional payback period for Machine No. 108 would be

1 2.22 years.
2 2.14 years. Correct
3 1.15 years.
4 3.00 years

Explanation :
Depreciation expense = $400,000 ÷ 5 years = $80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + ($80,000)
Cash flow, year 1 = ($150,000)(0.6) + $80,000 = $170,000
Cash flow, year 2 = ($200,000)(0.6) + $80,000 = $200,000
Cash flow, year 3 = ($225,000)(0.6) + $80,000 = $215,000
Cumulative cash flow after 2 years = $170,000 + $200,000 = $370,000
Cumulative cash flow after 3 years = $370,000 + $215,000 = $585,000
Payback is 2 years + ($400,000 − $370,000) ÷ ($215,000) = 2 + $30,000 ÷ $215,000 = 2 years + 0.14 years
= 2.14 years.

Now my question is why we consider depreciation expenses & avoid Tax shield portion?

secondly is their any special way of calculation in traditional methods

Request to clarify me
Thanks




------------------------------
Aaditya
------------------------------